Return on Assets (ROA) is a type of return on investment (ROI) metric that measures the profitability of a business in relation to its total assets. This ratio indicates how well a company is performing by comparing the profit (net income) it’s generating to the capital it’s invested in assets. The higher the return, the more productive and efficient management is in utilizing economic resources. Below you will find a breakdown of the ROA formula and calculation.
What is the ROA Formula?
The ROA formula is:
ROA = Net Income / Average Assets
ROA = Net Income / End of Period Assets
Net Income is equal to net earnings or net income in the year (annual period)
Average Assets is equal to ending assets minus beginning assets divided by 2
Let’s walk through an example, step by step, of how to calculate return on assets using the formula above.
Q: If a business posts a net income of $10 million in current operations, and owns $50 million worth of assets as per the balance sheet, what is its return on assets?
A: $10 million divided by $50 million is 0.2, therefore the business’s ROA is 20%. For every dollar of assets the company invests in, it returns 20 cents in net profit per year.
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What is the Importance of Return on Assets?
The ROA formula is an important ratio in analyzing a company’s profitability. The ratio is typically used when comparing a company’s performance between periods, or when comparing two different companies of similar size in the same industry. Note that it is very important to consider the scale of a business and the operations performed when comparing two different firms using ROA.
Typically, different industries have different ROA’s. Industries that are capital-intensive and require a high value of fixed assets for operations, will generally have a lower ROA, as their large asset base will increase the denominator of the formula. Naturally, a company with a large asset base can have a large ROA, if their income is high enough.
What is Net Income?
Net income is the net amount realized by a firm after deducting all the costs of doing business in a given period. It includes all interest paid on debt, income tax due to the government, and all operational and non-operational expenses.
Also added into net income is the additional income arising from investments or those that are not directly resulting from primary operations, such as proceeds from the sale of equipment or fixed assets. Note: non-operating items may be adjusted out of net income by a financial analyst.
Net income/loss is found at the bottom of the income statement and divided into total assets to arrive at ROA.
Video Example of Return on Assets in Financial Analysis
ROA is important because it makes companies more easily comparable. Imagine two companies… one with a net income of $50 million and assets of $500 million, the other with a net income of $10 million and assets of $15 million.
Which company would you rather own?
The first company earns a return on assets of 10% and the second one earns an ROA of 67%.
Below are some examples of the most common reasons companies perform an analysis of their return on assets.
1. Using ROA to determine profitability and efficiency
Return on assets indicates the amount of money earned per dollar of assets. Therefore, a higher return on assets value indicates that a business is more profitable and efficient.
2. Using ROA to compare performance between companies
It is important to note that return on assets should not be compared across industries. Companies in different industries vary significantly in their use of assets. For example, some industries may require expensive property, plant, and equipment (PP&E) to generate income as opposed to companies in other industries.
Therefore, these companies would naturally report a lower return on assets when compared to companies that do not require a lot of assets to operate. Therefore, return on assets should only be used to compare with companies within an industry. Learn more about industry analysis.
3. Using ROA to determine asset-intensive/asset-light companies
Return on assets can be used to gauge how asset-intensive a company is:
The lower the return on assets, the more asset-intensive a company is. An example of an asset-intensive company would be an airline company.
The higher the return on assets, the less asset-intensive a company is. An example of an asset-light company would be a software company.
As a general rule, a return on assets under 5% is considered an asset-intensive business while a return on assets above 20% is considered an asset-light business.
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